Sectors Most Exposed to Oil Price

In periods of high oil price volatility, there is much discussion of its impact on various industries. Market noise obscures true industry-specific performance, so Oil’s impact is impossible to judge from simple index returns. But, by stripping away market effects, we observe the relationships between pure sector and oil returns. Airlines have the largest negative exposure to Oil, yet REITs provide the most consistent negative exposure. In addition, sectors that benefit from increased discretionary spending are significantly negatively levered to Oil. Here we discuss the sectors most exposed to oil price, and quantify the relationships.

Pure Sector Performance

As we illustrated earlier, market noise obscures relationships among individual sectors, concealing industry-specific performance. Without separating pure industry-specific returns from the market, robust risk management, performance attribution, and investment skill evaluation are impossible.

For example, the oilfield services sector generally follows the market – industry trends are indiscernible:

Chart of the 10-year cumulative return of the oilfield services sector

Oilfield Services Sector Index Return

By removing market and macroeconomic effects from security returns and calculating the performance of the pure sector factor, we reveal sector-specific trends:

Chart of the 10-year cumulative return of the oilfield services pure sector factor

Oilfield Services Pure Sector Return

Within this pure sector performance, we can now identify:

Since pure sector factors capture sector-specific trends and risks, they also capture sector-specific oil exposure.

Equity Market’s Oil Exposure

In addition to industry-specific oil exposure, the broad equity market is significantly correlated with Oil. Broad macroeconomic risks affect both commodity prices and the equity market:

Chart of the historical correlation of monthly returns of oil price and U.S. equity market

Oil Price and U.S. Market Return Correlation

Over the past five years, when oil prices increased by 1%, the U.S. equity market increased by approximately 0.4%. Oil price variance explains approximately 28% of U.S. market variance. Perhaps more accurately, 28% of the market variance is explained by shared macroeconomic variables.

The exposure of an individual stock to Oil is a combination of exposures due to its market and pure sector risks.

Sectors Most Positively Correlated to Oil

The list of sectors with the highest positive correlation to Oil is hardly surprising:

Chart of the correlation of monthly returns of oil price and U.S. pure sector factors most positively correlated with oil price

Pure Sector Factors Most Positively Correlated with Oil Price

Sector Oil Correlation p-value
Industrial Machinery 0.29 0.0117
Oil and Gas Pipelines 0.31 0.0075
Contract Drilling 0.37 0.0018
Oilfield Services Equipment 0.38 0.0016
Integrated Oil 0.41 0.0006
Oil and Gas Production 0.43 0.0003

(We use the Spearman’s rank correlation coefficient to evaluate correlation. Spearman’s correlation is robust against outliers, unlike the commonly used Pearson’s correlation. All correlations are significant; most at 1% level or better.)

Some may find the oil price influence over the industrial machinery sector unexpected. This exposure reflects this sector’s dependence on the energy value chain.

Sectors Most Negatively Correlated to Oil

The list of sectors with the highest negative correlation to Oil is unexpected:

Chart of the monthly return correlation of oil price and U.S. pure sector factors most negatively correlated with oil price

Pure Sector Factors Most Negatively Correlated with Oil Price

Once again, all correlations are statistically significant, generally at 1% level or better:

Sector Oil Correlation p-value
Real Estate Investment Trusts -0.43 0.0003
Airlines -0.36 0.0021
Aerospace and Defense -0.34 0.0044
Multi Line Insurance -0.33 0.0053
Hotels Resorts Cruiselines -0.32 0.0067
Casinos Gaming -0.28 0.0142

A maxim among investors is that Airlines are the best way to get exposure to falling oil prices. Economic reality is more complex.

In fact, over the past five years, Real Estate Investment Trusts (REITs) have been most consistently negatively related to oil prices:

Chart of correlation between oil price and U.S. REIT pure sector factor

Real Estate Investment Trusts Pure Sector and Oil Return Correlation

Oil price variance explains approximately 19% of increases and decreases in REIT share prices.

Shared variables drive the performance or REITs and the performance of Oil: inflation, growth, and macroeconomic uncertainty.

Sectors Most Negatively Exposed to Oil

Correlation captures the strength of a relationship, or how well changes in one variable explain changes in the other, but it does not capture the magnitude of relative changes.

The magnitude of changes is captured by a regression: exposure (beta or regression term) measures the magnitude of pure sector changes due to oil price changes. Sectors with the largest oil exposure (beta) are:

Chart of the correlation between the oil price and U.S. pure sector factors for sectors most negatively exposed to the oil price

Pure Sector Factors Most Negatively Exposed to Oil Price

Airlines do indeed benefit the most when oil prices decline:

Sector Oil Exposure (Beta) p-value
Airlines -0.44 0.0007
Casinos Gaming -0.21 0.0531
Aluminum -0.20 0.0413
Hotels Resorts Cruiselines -0.18 0.0056
Motor Vehicles -0.18 0.0944
Real Estate Investment Trusts -0.18 0.0005

Over the past five years, when oil prices declined by 1%, the sector-specific performance of airlines has been approximately +0.4%:

Chart of the correlation between oil price and U.S. airlines pure sector factor

Airlines Pure Sector and Oil Return Correlation

The relationship between Oil and Airlines has not been as consistent as the relationship between Oil and REITs. However, the magnitude of changes in Airlines has been more than twice as large.

  • If investors seek short oil exposure with the most consistency, they should go long REITs.
  • If investors seek short oil exposure with the most “bang for the buck,” they should go long Airlines.

Hotels, Cruiselines, and Gaming are also featured on both lists. They offer a combination of consistency and “bang for the buck.” Presumably, they benefit from increases in consumer disposable incomes due to declines in energy prices.

Conclusion

  • Industry-specific performance is clouded by market noise.
  • By stripping away the effects of market and macroeconomic variables, we reveal the performance of pure sector factors and their relationships with oil prices.
  • Airlines are not the only, and not always the best, way to benefit from falling oil prices.
  • REITs benefit from falling oil prices most consistently.
  • Airlines benefit from falling oil prices less consistently than REITs, but with more leverage.
The information herein is not represented or warranted to be accurate, correct, complete or timely.
Past performance is no guarantee of future results.
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Content may not be republished without express written consent.
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